[Federal Register Volume 63, Number 5 (Thursday, January 8, 1998)]
[Notices]
[Pages 1131-1134]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-418]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39510; File No. SR-NASD-97-24]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 1 to the Proposed Rule Change by the National Association 
of Securities Dealers, Inc. Relating to Supervision and Record 
Retention Rules

December 31, 1997.

I. Introduction

    On April 11, 1997, the NASD Regulation, Inc. (``NASDR'') submitted 
to the Securities and Exchange Commission (``SEC'' or ``Commission''), 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to 
amend the supervision and record retention rules of the National 
Association of Securities Dealers, Inc.'s (``NASD'' or ``Association'') 
to provide firms with flexibility in developing reasonable procedures 
for the review of correspondence with the public. The proposed rule 
change was published for comment in the Federal Register on May 2, 
1997.\3\ One comment was received on the proposal.\4\
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 38548 (April 25, 
1997), 62 FR 24147.
    \4\ See Letter from William P. Hayes, Chairman, PSA The Bond 
Market Trade Association (``PSA'') Fixed Income Practices and 
Procedures Working Group, to Jonathan G. Katz, Secretary, 
Commission, dated June 3, 1997 (``PSA Letter'').
---------------------------------------------------------------------------

    On December 4, 1997, NASDR submitted Amendment No. 1 to the 
proposed rule change.\5\ This order approves the proposal, and approves 
Amendment No. 1 to the proposed rule change on an accelerated basis. 
The Commission also is approving a substantially identical proposal by 
the New York Stock Exchange, Inc. (``NYSE'').\6\
---------------------------------------------------------------------------

    \5\ See Letter from Mary N. Revell, Associate General Counsel, 
NASDR, to Katherine A. England, Assistant Director, Division of 
Market Regulation, Commission, dated December 1, 1997 (``Amendment 
No. 1''). Amendment No. 1 contains a Notice to Members (``Notice to 
Members''), to be issued following Commission approval of the 
proposed rule change, which describes the new rules for supervision 
of public correspondence and provides guidance to NASD members on 
the implementation of the new rules.
    \6\ See Securities Exchange Act Release No. 39511 (December 31, 
1997) (order approving File No. SR-NYSE-96-26).
---------------------------------------------------------------------------

II. Background and Description of the Proposal

    In May 1996, the Commission issued an Interpretive Release on the 
Use of Electronic Media by Broker-Dealers, Transfer Agents, and 
Investment Advisers for Delivery of Information.\7\ The release 
expressed the views of the Commission with respect to the delivery of 
information through electronic media pursuant to the federal securities 
laws, but did not address the applicability of any self-regulatory 
organization (``SRO'') rules. In the release the Commission did, 
however, strongly encourage the SROs to work with broker-dealer firms 
to adapt SRO supervisory review requirements governing communications 
with customers to accommodate the use of electronic communications.\8\
---------------------------------------------------------------------------

    \7\ See Release Nos. 33-7288, 34-37182, IC-21945, IA-1562 (May 
9, 1996) 61 FR 24644 (May 15, 1996) (File No. S7-13-96).
    \8\ Id.
---------------------------------------------------------------------------

    On September 12, 1996, the NYSE filed with the Commission a 
proposal to update its rules governing supervision of its member firms' 
communications

[[Page 1132]]

with the public.\9\ Similarly, NASDR proposes to amend NASD Rules 3010, 
``Supervision,'' and 3110, ``Books and Records,'' to provide firms with 
flexibility in developing reasonable procedures for the review of 
correspondence with the public. The NASDR's proposal, like the NYSE's 
proposal, reflects the growing use of new technology and means of 
cummunicaiton (e.g., ``e-mail'' and the Internet) which have affected 
the way broker-dealers and their associated persons conduct business 
and communicate with customers and other members of the public. 
According to NASDR, to ensure a coordinated regulatory framework for 
the supervision of written and electronic correspondence, its proposal 
is designed to be consistent with the NYSE's proposal.
---------------------------------------------------------------------------

    \9\ See Securities Exchange Act Release No. 37941 (November 13, 
1996) 61 FR 58919 (November 19, 1996) (File No. SR-NYSE-96-26) 
(soliciting comment on the NYSE's proposed rule change).
---------------------------------------------------------------------------

    Currently, NASD Rule 3010(d) requires each member firm to establish 
procedures for the review and endorsement by a registered principal of 
all transactions and all correspondence of its registered 
representatives pertaining to the solicitation or execution of any 
securities transactions. Under the proposal, a review of each item of 
correspondence no longer will be required. Instead, proposed NASD Rule 
3010(d)(1) provides that a firm must establish procedures for the 
review by a registered principal of each registered representative's 
outgoing and incoming written and electronic correspondence with the 
public relating to the member's investment banking or securities 
business. Under the proposal, member firms must: (1) Develop written 
supervisory policies and procedures; (2) design policies and procedures 
to provide reasonable supervision of each registered representative; 
and (3) maintain evidence that supervisory policies and procedures have 
been implemented and executed and make that evidence available to the 
Association upon request.
    A broker-dealer's policies and procedures for reviewing the public 
correspondence of registered representatives also must satisfy the 
requirements of new NASD Rule 3010(d)(2). As proposed, NASD Rule 
3010(d)(2) requires each member to develop written procedures for 
review of incoming and outgoing written and electronic correspondence 
that are appropriate to the broker-dealer's business, size, structure 
and customers. Pursuant to the proposal, a broker-dealer that does not 
require pre-use review of all correspondence must: (1) Educate and 
train associated persons as to the firm's procedures governing 
correspondence; (2) document such education and training; and (3) 
monitor and test to ensure implementation of and compliance with the 
firm's policies and procedures.
    The NASD has developed a Notice to Members that provides additional 
guidance and requirements for supervisory procedures adopted pursuant 
to NASD Rule 3010. In developing written supervisory procedures, 
members should, among other thing,: (1) Specify the firm's policies and 
procedures for reviewing different types of communications; (2) 
identify how supervisory reviews will be conducted and documented; (3) 
identify what types of communications will be pre-reviewed or post-
reviewed; (4) identify the organizational positions responsible for 
conducting reviews of the different types of communications; (5) 
specify the minimum frequency of reviews for each type of 
communication; (6) monitor the implementation of and compliance with 
the firm's procedures for reviewing public correspondence; and (7) 
periodically re-evaluate the effectiveness of the firm's procedures for 
reviewing public communications and consider any necessary revisions.
    In addition, the Notice to Members requires broker-dealer to: (1) 
Specify procedures for reviewing registered representatives' 
recommendations to customers; (2) require supervisory review of some of 
each registered representative's public communications, including his 
or her recommendations to customers; and (3) consider the complaint and 
overall disciplinary history, if any, of registered representatives and 
other employees. The Notice to Members also states that a broker-
dealer's supervisory policies and procedures must ensure that all 
customer complaints, whether received via e-mail or in written form 
from the customer, are reported to the NASD in compliance with NASD 
Rule 3070(c)\10\ and that a broker-dealer must prohibit employees' use 
of electronic correspondence to the public unless the communications 
are subject to the supervisory and review procedures developed by the 
firm.
---------------------------------------------------------------------------

    \10\ Among other things, NASD Rule 3070(c) requires members to 
report to the NASD statistical information regarding customer 
complaints relating to matters specified by the NASD.
---------------------------------------------------------------------------

    Moreover, under new NASD 3010(d)(3), each member must retain 
correspondence in accordance with amended NASD Rule 3110. NASD Rule 
3010(d) (3) further requires that the names of the persons who prepared 
and reviewed outgoing correspondence must be ascertainable from the 
retained records and the records must be made available to the NASD 
upon request.
    Finally, the NASD proposes to amend NASD Rule 3110 to require that 
records must be made and preserved as prescribed by all applicable 
laws, rules, regulations, NASD rules and with Rule 17a-3 under the Act. 
The record keeping format, medium, and retention period must comply 
with Rule 17a-4 under the Act.

III. Summary of Comments

    The Commission received one comment letter on the proposed rule 
change.\11\ The commenter generally supported the proposal. 
Specifically, the PSA believes the proposal will provide flexibility 
for member firms to develop procedures for review of correspondence. 
The PSA believes that procedures tailored by individual firms to meet 
their needs are preferable to a uniform set of detailed requirements 
that may be inappropriate for many firms or that may quickly become 
obsolete. The PSA expressed its support for the Association's efforts 
to ensure a coordinated regulatory framework for the supervision of 
manual and electronic communications by harmonizing its new 
requirements with those of the Commission and the NYSE.\12\
---------------------------------------------------------------------------

    \11\ See PSA Letter, supra note 4.
    \12\ Id.
---------------------------------------------------------------------------

IV. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
association.\13\ Specifically, the Commission believes the proposal is 
consistent with the requirements of Section 15A(b)(6) of the Act\14\ in 
that is designed to prevent fraudulent and manipulative acts and 
practices and to protect investors and the public interest. As noted 
above, NASD Rule 3010(d)(1), as amended, will allow broker-dealers to 
establish reasonable procedures for review of registered 
representatives' correspondence with the public relating to their 
business. New NASD Rule 3010(d)(2) will require broker-dealers to 
develop written policies and procedures for the review of all 
associated persons'

[[Page 1133]]

public communications that are appropriate for the broker-dealer's 
business, size, structure, and customers. The Commission believes that 
the proposed rules will provide broker-dealers with some flexibility in 
adopting and implementing supervisory procedures for reviewing 
associated persons' public communications while establishing minimum 
requirements, guidelines, and standards governing the supervisory 
procedures a broker-dealer may adopt. The Commission believes that 
these standards and guidelines will help to ensure that broker-dealers 
continue to provide appropriate supervision of the public 
communications of their associated persons.
---------------------------------------------------------------------------

    \13\ In approving this rule, the Commission notes that it has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \14\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    The Commission believes that the proposal does not diminish the 
general supervisory responsibilities of broker-dealers. In this regard, 
the Commission emphasizes, as it has stated previously, that broker-
dealers must monitor the trading and sales activities of their 
associated persons and establish effective compliance and supervisory 
procedures to prevent and detect possible violations of firm policies 
and procedures, rules of the SROs, and federal and state securities 
laws.\15\ The Commission believes that review of registered 
representatives' and other associated persons' public correspondence is 
an important component of a broker-dealer duty to supervise its 
employees, and that broker-dealers have substantial supervisory 
obligations arising from the public communications of their associated 
persons.
---------------------------------------------------------------------------

    \15\ See NASD, NYSE, North American Securities Administrators 
Association, Inc. and Office of Compliance, Inspections and 
Examinations, Commission, Joint Regulatory Sales Practice Sweep 
(1996) (``Joint Sweep Report'') at 1.
---------------------------------------------------------------------------

    The Commission believes that the minimum standards and requirements 
specified in NASD Rule 3010 and in the Notice to Members will help to 
ensure that broker-dealers continue to provide appropriate supervision 
of the public communications of their registered representatives and 
other associated persons. In this regard, the Commission notes that 
NASD Rule 3010(d)(1) states that a broker-dealer's supervisory policies 
and procedures must be designed to reasonably supervise each registered 
representative. Under NASD Rule 3010(d)(2), a broker-dealer that 
chooses not to require pre-use review of public communications must 
educate employees about the firm's current communications policies and 
procedures, document the employees' education and training, and ensure 
that the firm's policies are implemented and adhered to.
    In addition, the Notice to Members require broker-dealers to: (1) 
Specify, in writing, the firm's policies and procedures for reviewing 
different types of communications; (2) identify how supervisory reviews 
will be conducted and documented; (3) identify what types of 
communications will be pre-reviewed or post-reviewed; (4) identify the 
positions within the organization responsible for conducting reviews of 
the different types of communications; (5) specify the minimum 
frequency of reviews for different types of communications; (6) monitor 
the implementation of and compliance with the firm's procedures for 
reviewing public communications; and (7) periodically re-evaluate the 
effectiveness of the firm's procedures for reviewing public 
communications and consider any necessary revisions.
    The Commission believes that these requirements will provide 
guidance to broker-dealers in developing policies for supervising 
public communications and to associated persons in complying with the 
firm's policies. The requirements should help to ensure that broker-
dealers carefully consider the supervisory procedures appropriate for 
different types of communications, closely monitor compliance with 
their firm's policies, and periodically reevaluate their firm's 
policies and procedures. The Commission expects broker-dealers to 
monitor the effectiveness of their supervisory policies and procedures 
and to promptly make any necessary revisions.
    The Notice to Members also requires broker-dealers to: (1) Specify 
procedures for reviewing registered representatives' recommendations to 
customers; (2) require supervisory review of some of each registered 
representative's public communications, including his or her 
recommendations to customers; (3) consider the complaint and overall 
disciplinary history, if any of registered representatives and other 
employees in developing procedures for supervising their communications 
with the public; (4) provide that all customer complaints, whether 
received via e-mail or in written form from the customer, are reported 
to the NASD in compliance with NASD Rule 3070(c); and (5) prohibit 
employees' use of electronic communications to the public unless the 
communications are subject to supervisory and review procedures 
developed by the firm.
    The Commission believes that these standards will help to ensure 
that broker-dealers adopt effective and appropriate supervisory 
procedures. For example, reviewing at least some of each registered 
representative's recommendations \16\ and providing for the reporting 
of customer complaints in compliance with NASD Rule 3070(c) may help 
firms to identify potential sales practice problems. Similarly, 
considering a registered representative's complaint and overall 
disciplinary history will help to ensure that broker-dealers implement 
supervisory procedures appropriate for each representative. In this 
regard, the Commission would expect a broker-dealer to consider 
providing heightened supervision for a registered representative with a 
history or pattern of customer complaints, disciplinary actions or 
arbitrations.\17\ Moreover, the Commission notes that the requirements 
specified in NASD Rule 3010 and in the Notice to Members are minimum 
requirements; the Commission expects each broker-dealer to implement 
any additional procedures the broker-dealer believes are necessary to 
provide appropriate supervision of all of its associated persons.
---------------------------------------------------------------------------

    \16\ With regard to recommendations, the Commission notes that 
NASD Rule 2310 requires, among other things, that a recommendation 
have a basis which can be substantiated as reasonable. Regardless of 
the supervisory procedures a broker-dealer adopts, the broker-dealer 
must continue to ensure compliance with NASD Rule 2310 and any other 
relevant rule.
    \17\ Similarly, the Joint Sweep Report stated that ``[f]irms 
that hire registered persons that have a history or pattern of 
customer complaints, disciplinary actions, or arbitrations are 
responsible for imposing close supervision over those persons. 
`Normal' supervision is simply not enough; firms must craft special 
supervisory procedures tailored to the individual representative.'' 
See Joint Sweep Report, supra note 21, at vi. See also NASD Notice 
to Members 97-19 (firm that hires a registered representative with a 
recent history of customer complaints, final disciplinary actions 
involving sales practice abuse or other customer harm, or adverse 
arbitration decision should determine if it is necessary to develop 
and implement special supervisory procedures tailored to the 
individual registered representative).
---------------------------------------------------------------------------

    The Commission believes that several requirements specific to 
electronic communications will further help to ensure that firms adopt 
appropriate supervisory procedures. In this regard, the Commission 
notes that the Notice to Members provides that a firm's policies and 
procedures must prohibit registered representatives' and other 
employees' use of electronic communications to the public unless those 
communications are subject to supervisory and review procedures 
developed by the firm. The NASD Notice to Members also states that the 
Association expects members to prohibit communications with the public 
from employees' home computers or through third party computer systems 
unless the firm is

[[Page 1134]]

capable of monitoring the communications.
    The Commission believes that the provision for review of incoming 
non-electronic correspondence also is designed to protect investors. 
The Commission notes that the Notice to Members mandates that Rule 
3010(d) will continue to require review of all incoming non-electronic 
correspondence directed to registered representatives.\18\ The 
Commission believes that this requirement may provide a broker-dealer 
with early notice of sales practice problems and help to ensure proper 
handling of customer funds. Incoming non-electronic correspondence 
directed to associated persons other than registered representatives, 
and all incoming communications in electronic format, will be subject 
to the policies and procedures the firm establishes pursuant to NASD 
Rule 3010(d).
---------------------------------------------------------------------------

    \18\ See Notice to Members, supra note 5. The requirement to 
review all incoming non-electronic correspondence directed to 
registered representatives is not specified in the text of the rule 
language. This requirement parallels a NYSE provision contained in 
Interpretation 342.16/04 in the NYSE Interpretation Handbook. The 
NASD's requirement is set forth only in its Notice to Members which 
was submitted by NASDR as an amendment to the original rule filing; 
therefore, NASD member firms must comply with this additional 
requirement, as well as with the other specific requirements set 
forth in the Notice to Members.
---------------------------------------------------------------------------

    The NASD represents that it will review members' procedures and 
systems periodically to ensure that they are reasonable in view of the 
firm's structure, the nature and size of its business, and its customer 
base.\19\ The Commission expects the NASD to monitor closely the 
policies and procedures firms adopt pursuant to the proposal to ensure 
that they satisfy the requirements of NASD Rule 3010. In addition, the 
Commission expects the NASD to review NASD Rule 3010 as it gains 
experience with the rules and to consider any necessary revisions, 
including additional minimum requirements for broker-dealers' 
communication policies.
---------------------------------------------------------------------------

    \19\ Id.
---------------------------------------------------------------------------

    Finally, the Commission believes that it is reasonable for the NASD 
to amend NASD Rule 3110 to indicate that members must preserve books 
and records as required under SEC Rule 17a-3 and comply with the 
recordkeeping format, medium and retention period specified in SEC Rule 
17a-4 in order to clarify the recordkeeping requirements applicable to 
broker-dealers.
    The Commission finds good cause for approving proposed Amendment 
No. 1 prior to the thirtieth day after the date of publication of 
notice of filing thereof in the Federal Register. The Commission notes 
that Amendment No. 1, which incorporates the Notice to Members into the 
proposal, further clarifies the Association's new rules by providing 
additional guidance to NASD members. As discussed more fully above, the 
Notice to Members provides additional requirements and guidelines for 
broker-dealers' supervisory policies. Accordingly, the Commission 
believes that it is consistent with Section 15(b)(6) of the Act \20\ to 
approve Amendment No. 1 to the proposed rule change on an accelerated 
basis.
---------------------------------------------------------------------------

    \20\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 1. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, 
D.C. 20549. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Section, 450 Fifth Street, 
N.W., Washington, D.C. 20549. Copies of all such filings will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to File No. SR-NASD-97-24 and should 
be submitted by January 29, 1998.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\21\ That the proposed rule change (SR-NASD-97-24), including 
Amendment No. 1, is approved.

    \21\15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

    For the Commission, by the Division of Market Regulations, 
pursuant to delegated authority.\22\
---------------------------------------------------------------------------

    \22\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

[FR Doc. 98-418 Filed 1-7-98; 8:45 am]
BILLING CODE 8010-01-M